Federal Trade Commission to Employers: Non-Compete Agreements R.I.P.
Yet another massive overreach by your pals in the Federal Government
Today’s post was supposed to be Part I of the Free Speech Primer, but that will appear later because today the Federal Trade Commission issued a final rule so obnoxious in its overreach that it has to be addressed immediately - because it potentially affects all workers and companies in all industries.
The Federal Trade Commission issued its final Non-Compete Clause Rule, which can be found at 16 C.F.R. Part 910 (the “Final Rule”). It is important to note that the effective date of the Final Rule is 120 days following its publication in the Federal Register.
The Final Rule Purports to Invalidate Non-Compete Agreements
Non-compete agreements (“Non-Competes”) are a common and useful legal tool to protect the legitimate business interests of employers. These are either stand alone contracts or clauses contained within an employment agreement which restrict the worker’s ability to compete against the business following the termination of employment for a defined period of time (typically anywhere up to 5 years after separation) within a certain geographical restriction zone.
The geographical restriction zone often must mirror the footprint of the employer’s existing customer base. If ABC Company sells products only within the (610) area code, then ABC Company’s Non-Competes are likely enforceable if a former employee was hired by a competitor that also sells to the (610) area code, but likely not enforceable elsewhere. There are more nuances to this concept, but the above states the general rule, until now.
The Final Rule provides that it is an unfair method of competition for a person other than a senior executive to:
(i) To enter into or attempt to enter into a non-compete clause;
(ii) To enforce or attempt to enforce a non-compete clause; or
(iii) To represent that the worker is subject to a non-compete clause.
Final Rule, § 910.2.
One has to read between the lines here. The above prohibition applies to both future and existing non-competes. In other words, if you are a company that has previously negotiated a contract with a worker, and that contract has a non-compete clause, the non-compete clause is now legally unenforceable. There is a different rule for senior executives, see below.
Under Pennsylvania law, to render the non-compete enforceable, an employer either had to: 1) present the contract to the employee at the time of hiring, or 2) provide a signing bonus to a current employee to create legal consideration sufficient to render the non-compete an enforceable contract. Do the employers have a right to claw the signing bonuses back? Of course, the Final Rule is silent on that matter.
The Finale Rule treats “senior executives” differently. For “senior executives”, the Final Rule only applies to future contracts. The Final Rules prohibits entering into or enforcing a non-compete agreement after the effective date of the Final Rule.
What is a “senior executive”? The Final Rule defines a “senior executive” as a worker who was: 1) in a policy making position and 2) received total annual compensation exceeding $151,164 in the prior year. See Final Rule §910.1(2).
EXCEPTIONS
NOTE: The Final Rule does not apply to Non-Competes entered into by a person pursuant to a bona fide sale of a business entity. See Final Rule §910.1(3). Those agreements are still legally permissible. The Final Rule also does not cover Non-Disclosure Agreements.
A copy of the Final Rule, which is an eye-watering 570 pages, can be read in its entirety below. [N.B. the highlights contained in the embedded .pdf are mine.]
BUT WAIT! THERE’S MORE!
Another gem in the Final Rule is that employers have an affirmative duty to notify workers about the Final Rule.
For each existing non-compete clause that it is an unfair method of competition to enforce or attempt to enforce under paragraph (a)(1)(ii) of this section, the person who entered into the non-compete clause with the worker must provide clear and conspicuous notice to the worker by the effective date that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker. Final Rule § 910.2(b).
The form of the notice is provided in the Final Rule. The form of the notice is below:
The Prior State of the Law in Pennsylvania
The state of the law in Pennsylvania, prior to the Final Rule, gave state court judges broad authority to modify (in the legal business called “blue penciling”) the terms of non-compete agreements that were the subject of a legal dispute in their courts. It is not, then, correct to ever have said that non-competes were iron clad and always enforceable in Pennsylvania and other states. With judicial scrutiny of non-competes by Pennsylvania judges there was one key concept that was central to the court’s analysis: Do the terms of the non-compete protect the company’s legitimate business interests?
For example, you own a software company. You produce software solutions for industrial applications. Your customers (for the sake of this example) are all located in the (717) area code. Thus, you have a legitimate business interest in protecting the (717) area code from being poached by a former employee because that is where your revenue is generated.
The other main feature of the pre-Final Rule state of the law is that non-competes were not enforceable against a former employee who you have terminated for poor performance. Your enforcement would be at odds with the rationale of having the non-compete in the first place: this employee is so integral to our business that if he or she directly competes against us in our footprint we are going to be financially harmed. If that employee were to be terminated for poor performance, then the now former employee cannot pose that much of a threat.
Quick Prediction
The language of the Final Rule purposes to regulate non-competes in all businesses in all industries, whether those non-competes are currently being negotiated or have already been signed. It is scope is egregiously broad. My expectation is that the Final Rule as it is written does not survive a judicial challenge, especially the parts of the Rule which purport to invalidate existing non-competes after the fact.
This issue will evolve rapidly, and more updates will follow as they happen.
J. Bryan Tuk is a business attorney with 25 years experience representing small businesses, creatives and nonprofit organizations at Tuk Business & Entertainment Law. He is the author of risk, create, change: a survival guide for startups and creators.